Kyle Bass Says Blackballing Oil Has Proved a Bad Bet for ESG

(Bloomberg) -- One of the most contentious investing strategies on Wall Street might be a lot less beleaguered right now if its defenders had shown a bit more moderation from the get-go, according to Kyle Bass.

The hedge fund veteran and founder of Hayman Capital Management says the backlash that’s been building against environmental, social and governance investing in recent years is largely due to climate activists’ demands that fossil fuels be abandoned here and now. As a proposition, that was never tenable or even responsible, he says.

“There were all of these idiots that were just saying, if anyone is doing hydrocarbons, we’re going to blackball them from doing business or from receiving capital,” Bass said in an interview. “And so Texas lashed back and said, if you’re going to blackball someone that’s producing hydrocarbons, we’re not going to do business with you either.”

It’s a line of argument that gets to the heart of an increasingly entrenched standoff between much of Wall Street and the climate movement. A recent case in point is the months-long campaign outside the Manhattan headquarters of Citigroup Inc., which has seen tense encounters between bankers and protesters. 

Protest organizers have galvanized enthusiasm using slogans like “Hot People Hate Wall Street” and “Eat the Rich.” So far, dialogue has been limited and neither side has made any concessions of note.

Bass, who has spoken up in favor of agendas on various sides of the US political debate spanning tariffs on China to abortion rights, is the latest in a list of increasingly vocal financial professionals to characterize such climate activism as naive. Others to have made similar points include KKR & Co. co-founder Henry Kravis, as well as the chief executives of JPMorgan Chase & Co. and Goldman Sachs Group Inc., Jamie Dimon and David Solomon.

“Energy transitions take 40 or 50 years,” Bass said. There are people who “think we can just turn hydrocarbons off and turn on alternative power. But they have no idea how the grid works and no idea how business works.”

The focus now should be on energy efficiency and electrification, with a full transition to nuclear in the long run, he said. Until then, it’s more realistic to accept that fossil fuels and renewable energy sources are “going to coexist for decades and decades to come,” Bass said.

Many Wall Street firms who initially signed up to net zero alliances have since found themselves on the receiving end of bans in Republican states that target firms seen as hostile toward fossil fuels. Those same firms are now becoming more vocal in their support of oil and gas clients.

“Skirting hydrocarbons is like bringing politics into investing,” Bass said. “If you’re willing to give up returns for that, then so be it. But I think that’s naive and it’s a breach of fiduciary duty.”

Texas, where Bass is based, passed two laws in 2021 that restrict government contracts with companies that take what state officials regard as punitive stances toward the fossil-fuel and firearms industries. The legislation, which is now being challenged in the courts, has prompted state officials to place restrictions on financial firms including Citigroup, Barclays Plc and BlackRock Inc. 

The Sunrise Project, a nonprofit focused on the financial sector’s contribution to global warming, says such legislation represents a “bad-faith” attempt to “punish financial-service providers for managing investment risk.” The group points to evidence that laws like those in Texas ultimately end up costing taxpayers money. 

At the same time, climate scientists warn that the planet is reaching dangerous tipping points as rising emissions trigger increasingly deadly floods, wildfires and droughts. Continued bankrolling of the fossil fuels that directly add to those emissions is contributing to a climate catastrophe and must be urgently reined back, they say.

The International Energy Agency says that by 2050, unabated fossil fuels should account for just 5% of the total energy supply in order to achieve the goal of limiting global warming to no more than 1.5C above pre-industrial levels. 

Meanwhile in Europe, which is home to the world’s biggest ESG investing rulebook, regulators are adjusting their stance. There’s now an extensive review underway of existing regulations with a view to allowing a less absolutist stance on fossil fuels. In essence, investors who can show they’re helping a company with a big carbon footprint transition toward a greener future will likely be able to call that an ESG strategy.

ESG investors have already started adjusting their strategies to reflect expectations that regulations will be more accommodating toward the fossil-fuel sector. A recent study by analysts at Goldman Sachs found that ESG funds are now more exposed to the oil and gas industry than they were just a year ago.

Changes in the ESG regulatory backdrop in Europe “could drive flows towards companies traditionally excluded,” according to a team of Goldman analysts that included Evan Tylenda and Grace Chen.

Meanwhile, Bass is himself adapting to a greener future by specifically targeting investment projects that protect the natural environment. Since 2021, he’s been buying up land through his private equity firm, Conservation Equity Management, with a view to shielding forests from over-exploitation and monetizing environmentally fragile habitats. 

Bass, who shot to fame after successfully betting against US subprime home loans during the financial crisis of 2008, says there are clear opportunities to make money from nature conservation. In fact, he says he’s seeing enough external investor demand to allow him to expand his strategy.

“We’re focusing on mitigating or offsetting physical impacts on the environment,” Bass said. “And we’re going to make a pretty penny in doing so.”

Part of Bass’s venture involves generating so-called mitigation banking credits, which are tradable units that can be bought by companies required by law to compensate for their environmental impact.

Whether it’s renewable energy developers or oil producers, companies still need to offset the damage they do to nature, Bass said.

Ultimately, Texan support for fossil-fuel producers has “only made it better” for investment strategies like his that are linked to selling offsets, Bass said.

(Adds IEA reference in 14th paragraph.)

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